How to Calculate the True Cost of a Mortgage

When you buy a house, you typically don’t pay the entire purchase price outright. A mortgage allows you to have the benefits of owning a home while paying down the loan you borrowed in order to buy the house. The total cost of the loan will be much higher than the purchase price. That’s because the cost of interest is added to the loan. The interest rate you pay is compounded monthly for the life of the loan. There are also lender fees added to the loan.

Tip

In order to calculate the trust cost of a mortgage, you must add the overall value of interest generated by the mortgage to the amount of principal borrowed.

Defining Loan Principal

The money going toward the actual balance of your loan is called the principal. If you put a down payment on the house of 20 percent of the total cost, you are borrowing the other 80 percent. For example, if you are buying a house for $300,000, and plan to put $60,000 down on the house, this means the principal or the actual balance is $240,000.

Once you have signed a contract for a house, you will need to shop around for your mortgage from banks or other lending institutions. Your mortgage will have an interest rate. If that rate is fixed, it will remain at that level for the life of the loan.

30-Year Mortgage Basics

On a 30-year mortgage with a 5-percent fixed interest rate, the monthly payments for a $300,000 house with a 20 percent down payment would be $1,288 plus taxes and insurance. If you pay your mortgage each month for the life of the loan, you will pay $463,680. Add in the $60,000 down payment, and this brings your cost for the house to $523,680.

If you take out a mortgage with an adjustable interest rate, you may end up paying more, depending on how much the interest rate increases.

15-Year Mortgage Terms

If you decided to go with a 15-year fixed-interest-rate mortgage, your total cost will drop. Usually, a shorter loan period gives you a lower interest rate. So, for example, consider the $300,000 house with a 4-percent interest rate. After you've made your down payment of $60,000, your monthly payments will be $1,775, plus taxes and insurance. Your total mortgage cost will be $319,500. Add in the $60,000 down payment, and that brings the total cost up to $379,500. So by adding a few hundred dollars a month to your mortgage, you’ll save $144,180 over the life of the loan.

Taxes and Insurance

Taxes and insurance do not figure into the cost of the house, but these are a reality for every homeowner. For that $300,000 house, taxes and insurance costs average around $180 a month, although that figure varies considerably depending on where you live. Also, if you live in a development with an HOA fee, you’ll need to add that cost in, as well.

Lowering Your Total Cost

Even if you go with the 30-year mortgage figure, one way to lower your total cost is to add extra money on top of your mortgage, which will go directly to your principal. Even if you put $100 a month toward the principal, over the life of the loan you can save considerably.

Understanding Lender Fees

Your total cost calculation should also include closing costs or other fees the bank charges to take out your loan. This is where you can compare lenders. Closing costs are the fees the bank charges to process the loan. These are usually about 2-to-5 percent, and the buyer pays these when the contract is signed.

Points are sometimes paid as a way to lower the interest rate. One point is equal to 1 percent of the loan amount. Borrowers typically pay from zero to four points which can be negotiated with your lender. Points can lower the overall cost of the loan and should be considered if you think you’ll be in your home for longer than five years.

Tip

Taking a mortgage with a shorter term saves you a lot in interest over the life of the loan. For example, say you took out the same $200,000 mortgage at 6 percent, except for a 15-year term. The monthly payment goes up to $1,687.71, but over the life of the loan, your interest totals only $103,788.46, compared to $231,676 in interest on the 30-year loan.

About the Author

Karen Gardner is a former feature editor and writer and is now a freelance writer. She looks forward to doing her family's taxes each year, and likes to write about home finances and money subjects for the rest of us.